The article “Should you pay off student debt before investing?” was originally published in MoneySense on August 22, 2023, reposted September 1st, 2023.
If you want to start investing but you’ve got a Canada Student Loan or other student debt to repay, here’s how to decide where to put your money.
Recent graduates and other young people face competing financial priorities. Once you join the workforce, it’s understandable if you want to shed the student lifestyle and live a little. But at some point, you’ll need to decide what to do with extra cash flow: invest or pay back student loans. Like many things in personal finance, it depends on your situation—including what type of student loans you have.
Investing vs. debt repayment
The financial industry spends a lot more time talking about investing than debt repayment, so that can be an enticement to start building an investment portfolio. Investing has become more gamified as well, and many young people know someone—perhaps indirectly through social media—who has made it rich investing in meme stocks, cryptocurrencies or NFTs. This can lead to a fear of missing out.
The truth is that most investors make money slowly over time, and even the professionals have a tough time keeping pace with stock market returns, let alone beating the market. As a result, it can pay to take a long-term approach when deciding between investing and debt repayment and choose what works best for your situation.
One of the goals of financial planning is to build your net worth. Your net worth is calculated by taking your assets and subtracting your liabilities. When you are young, sometimes this formula results in a negative net worth. But whether you build your assets or reduce your liabilities, both increase your net worth. And both are good to do financially. Which is better for you depends on a few factors.
No more interest on Canada Student Loans
If you have a Canada Student Loan, you’ll be glad to know the federal government permanently eliminated interest on these loans as of April 1, 2023. Any interest accumulated prior to that date must still be repaid, but no new interest is accruing. The province of New Brunswick has done the same for Canada–New Brunswick integrated student loans.
As a result, some student debt is interest-free, which makes it less time-sensitive to repay. If you can invest in even a high-interest savings account—let alone a guaranteed investment certificate (GIC), stock, bond, exchange-traded fund (ETF) or mutual fund—and earn a higher rate of return than zero, you will be better off investing than paying down your interest-free student debt.
That said, you still need to make payments on federal student loans, starting six months after you are no longer a full-time student. These payments have an impact on your ability to qualify for other credit, including a mortgage or car loan, so there is a benefit to paying your debt off.
Interest on provincial student loans
Provincial or bank student loans will generally have interest payable. If you have a debt with a 5% interest rate, and you have the option to pay it down or invest, you generally need to earn a return higher than 5% to be better off investing. There can be exceptions, like if you have a company retirement or savings plan with an employer matching your contributions. This can make investing the better choice.
You can claim student loan interest on your tax return, though, and this can make your after-tax interest cost a bit lower. You can claim student loan interest you paid in the current year or the previous five years if you received the loan under:
- Canada Student Loans Act
- Canada Student Financial Assistance Act
- Apprentice Loans Act
- Provincial or territorial government laws similar to the acts above
The tax savings is generally about 20% of the interest paid. This varies slightly based on your province or territory of residence.
Do student loans affect credit scores in Canada?
Yes—all debts have an impact on your credit score, but as long as you are making your payments on time, a student loan is unlikely to have a significant negative impact. If you have a high debt level relative to your income, this can have an impact on the total debt you can borrow. But a clean repayment history with no missed or late payments will be the most important thing that could influence your credit score.
Do student loans count as income?
No, student loans don’t count as income. It is not uncommon for people to wonder about this. Student loans may be based on income, though—specifically family income. Your family status and income may impact your eligibility for student loans and various student grants you might apply for.
What to think about before starting to invest
So, if you have an interest-free student loan, employer-matched contributions on an investment account, or a relatively high investment risk tolerance, you may be in a position to consider investing instead of paying down student debt.
The risk tolerance angle is tricky. Young people may have a high risk tolerance just by their nature. Or they may be told by financial advisors or family members to invest aggressively because they are young and have a long time horizon.
However, quite to the contrary, young people often have a relatively short time horizon to invest. You may need your savings sooner rather than later for further education, cash flow between job changes, a car, first and last month’s rent, furniture, travel, a home down payment, an engagement ring, a wedding or a baby, amongst other costs. Young people also tend to have limited investing experience, and this may subject them to a greater likelihood of losses if they do not understand an investment properly or have a knee-jerk reaction to investment volatility.
Paying down student debt is never a bad choice. But if you’re investing instead of paying down debt, be sure to take advantage of tax-preferred accounts—especially a tax-free savings account (TFSA).
And if you’re paying down debt, make sure to understand loan repayment rules and requirements and the interest cost, and do not miss any tax credits for student loan interest paid.
